Inheritance tax is worked out on a rolling total of gifts you have made over the last seven years. What you leave on death is in effect your final gift. So to the estate you leave are added any gifts you made in the seven years before death unless they were tax-free gifts.
Some or all of your estate may be free of inheritance tax: anything left to your spouse or civil partner, or to a UK charity. These tax-free bequests and legacies are deducted from the value of your estate before the tax bill is worked out.
Your tax-free allowance
If the resulting total exceeds a certain limit – inheritance tax is payable on the excess at 40 per cent. So in 2010–11 if the total is £350,000, tax is payable on £350,000 – £325,000 = £25,000 and the bill would be 40% £25,000 = £10,000.
Each person has their own tax-free allowance (called the ‘nil-rate band’). But, under special rules, the allowance of a person dying on or after 9 October 2007 may be increased by any unused allowance from a husband, wife or civil partner who predeceased them (whatever the date of their death). For example, if when a husband died, his estate used up only 30 per cent of his allowance, the allowance available at the wife’s death could be increased by up to 70 per cent. This means that a widow, widower or bereaved civil partner who dies in 2010–11 may have a tax-free allowance up to 2 £325,000 = £650,000.
To transfer unused allowance, no action is required when the first of a married couple or civil partnership dies. On the second death, the personal representatives need’s to fill in form IHT216 and submit it within two years of the month in which the second death occurred, together with documents to support the claim. These documents which relate to the first death include, for example, a copy of the inheritance tax form submitted (IHT 200, C5 or IHT205), the death certificate, will or details of how the estate was passed on if there was no will, any deed of variation, any valuations. Note that there is unlikely to be any unused allowance to carry forward if your spouse died before March 1975 because the exemption for gifts between husbands and wives was then very small and non-existent before March 1972.
Kamil died in October 2003, leaving an estate worth £153,000. This used up 60 per cent of the tax-free allowance for 2003–04, which was £255,000. His wife Ayesha dies in July 2010. Her estate is worth £410,000 which exceeds the tax-free allowance for 2010–11 of £325,000. But her personal representatives can claim the unused part of Kamil’s allowance to boost Ayesha’s allowance up to 140% – £325,000 = £455,000. This would more than cover her estate, so no inheritance tax would be due.